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Credit FAQ: How The Economy, Profitability, And Regulations Could Support Certain U.S. Bank Ratings

S&P Global Ratings has observed positive developments in the U.S. banking system, related mostly to the country's improved regulatory track record for banks, the good financial performance of its banks prior to and during the COVID-19 pandemic, and the rebounding economy. We have therefore announced a change in parts of our Banking Industry Country Risk Assessment (BICRA) for the U.S. (see "Various Rating Actions Taken On Large U.S. Banks And Consumer-Focused Banks Based On Favorable Industry Trends" and "Various Rating Actions Taken On U.S. Regional Banks Based On Improving Economy And Favorable Industry Trends").

We use the BICRA to set the anchor, or starting point, for our ratings on financial institutions in each given country. The announced changes could, within one to two years, result in a higher anchor for the U.S. and therefore higher ratings on some banks and--though less likely--nonbank financial institutions (NBFIs). Below we answer several frequently asked questions about the changes.

Frequently Asked Questions

What has changed S&P Global Ratings' views of the strength and resilience of the U.S. banking system?

The rebound in the U.S. economy, improved bank regulation, and the good financial performance of banks over many years have given us greater confidence in the strength and resilience of the U.S. banking system.

The outlooks for the economy and asset quality have improved dramatically over the past several months on the back of government stimulus, extraordinary actions by the Federal Reserve, and vaccine distribution. S&P Global economists expect U.S. real GDP growth of 6.5% in 2021 and 3.1% in 2022.

With such robust growth and stimulus, we have lowered our forecast for pandemic-related credit losses, absorbed in roughly 2020-2022, to 1.4%-1.8%, well below our prior forecasts of 2.2% (published in December 2020) and 3.0% (published in July 2020). Banks generally have already provisioned enough to cover those losses, and allowance levels should decline this year as a result.

The track record of bank regulation and stability in the U.S. has also improved greatly since a low point during the global financial crisis of 2008-2009. We believe the solid performance of U.S. banks over the several years prior to and during the pandemic reflects well on the long list of regulatory and supervisory enhancements implemented in response to that crisis. Those enhancements were related to capital, liquidity, underwriting, operational risk, stress testing, resolution, and governance, among other factors.

We look most favorably on the regulation applied to banks under enhanced supervision (generally those with more than $100 billion in assets), which make up the majority of the assets in the banking system. Those banks, especially the global systemically important banks (GSIBs), face some of the toughest regulation and supervision in the world, in our view.

On top of that, the balance sheets of U.S. banks in many respects look as strong as they have in many years, with especially robust levels of deposits. Banks also have healthy capital, in part due to the Fed's stress testing and pandemic limitations on shareholder payouts; stout funding and liquidity, with the lowest ratio of loans to deposits in decades; and asset quality that has largely held together despite the pandemic stresses. The implementation of the Current Expected Credit Losses accounting standard in the U.S. just prior to the pandemic probably has also resulted in U.S. banks holding higher allowances for loan losses than most banks in other regions, all else equal.

The extraordinary actions the government and the Fed have taken to support the economy and financial markets have indirectly been enormously beneficial to financial institutions, helping them to maintain solid financial positions and good asset quality. However, a future crisis may look very different from the current one, and we are not factoring into our ratings any expectation that the government will always respond in such a beneficial way to U.S. financial institutions. Nevertheless, we look positively on the benefits that have accrued to them during this period.

How are you incorporating the improvement in these economic and industry factors in your ratings?

We are incorporating these factors in our BICRA for the U.S. For each country where we rate banks, we use the BICRA--an overarching analysis of the country's economic and industry risks--to set the starting point, or anchor, for ratings on banks that operate primarily in that market.

Our anchor for a bank operating mainly in the U.S. (including Puerto Rico) is 'bbb+', based on our assessment of economic and industry risk. However, we now view industry risk as being on a positive trend, based on the improved regulatory track record in the U.S. and the long-running strength of banks' performance and balance sheets. Furthermore, we have changed our view of the economic risk trend to stable from negative, given the ongoing economic rebound. (We changed the economic risk trend to negative from stable early in the pandemic.)

The positive industry risk trend indicates we may take a more favorable view of that factor, which could result in us revising the anchor to 'a-' from 'bbb+' in the next one to two years. More specifically, we may revise up the anchor if the current stringency of regulation remains in place, the economy continues to grow, and banks maintain strong balance sheets and good asset quality as they emerge from the pandemic.

If the U.S. anchor moved to 'a-', it would be the same as in lower-risk systems currently including Austria, Belgium, Canada, Finland, Germany, Hong Kong, Liechtenstein, Luxembourg, Norway, Singapore, Sweden, and Switzerland.

What could prevent you from revising the anchor to 'a-' for ratings on banks in the U.S.?

We are unlikely to revise up the anchor in the next one to two years if overheating in the economy or asset bubbles threaten financial stability, ultralow interest rates or other factors weigh significantly further on banks' preprovision profitability, bank regulation unexpectedly weakens, or other factors threaten financial stability. We recognize that equity valuations, home prices, and some other asset valuations have already risen sharply, with accommodative monetary policy likely helping to spur those increases. We don't yet see those increases as a major threat to financial stability or bank creditworthiness, but we will continue to monitor such trends.

If we see overheating as a rising threat to financial stability or if regulation eases, we likely will no longer consider moving the anchor higher. Instead, we may change our view of the trend on industry risk to stable or the trend on economic risk to negative.

Would a change in the anchor to 'a-' necessarily cause you to raise all bank ratings in the U.S.?

No. If we revise up the anchor, we will review every bank that we rate in the U.S. in a ratings committee at that time, but not every rating will necessarily move higher, and many may not.

We have signaled which bank ratings we see as having the greatest chance of moving higher with a higher anchor, by revising our outlooks on those ratings to positive. Most of those are large banks: Bank of America Corp., JPMorgan Chase & Co., Morgan Stanley, PNC Financial Services Group Inc., and Truist Financial Corp.

In our view, those banks have benefited from improving industry risk and stabilizing economic risk, and they have shown significant franchise, financial, and risk management strengths commensurate with higher-rated peers. They generally have demonstrated such strengths over many years and in some cases made positive enhancements to their business or financial positions in recent years. While they make up a small portion of the banks we rate, they account for about one-third of assets in the U.S. banking system. Because of their large size, all face enhanced supervision.

They also have substantial scale and diversification, two factors that we believe have grown in importance for banks. Advancements in financial technology and increased competition can disrupt individual business lines, making it imperative to have strength in multiple areas and advantageous to have a sizable budget for technology. We believe the increased advantages of diversification and scale have spurred the rise in significant merger activity in recent years, and consolidation is likely to continue, particularly among community and regional banks. Many of those banks rely heavily on in-market commercial real estate and small-business lending, which can be risky, with limited diversification from fee income sources.

If we ultimately do not revise the anchor upward, the probability of upgrading any of the above banks will fall materially. That said, the strengths of some could conceivably cause us to still consider raising our ratings on them, depending also on the reasons that we opted not to revise up the anchor and the relevance of those reasons to the ratings.

At this point, we have less confidence that we would raise the ratings on most other U.S. banks even with a higher anchor. We have stable rating outlooks on most of those banks, along with a small number of positive and negative outlooks, in large part due to idiosyncratic reasons.

At a higher anchor, we would increasingly compare banks in the U.S. with peers in stronger banking systems such as Canada and Switzerland, many of which tend to have strong business and financial positions. Comparisons on average would become more challenging than those against banks with weaker anchors.

Enhanced supervision has factored into most of the positive outlook revisions we announced. However, that alone won't drive a bank rating higher, particularly if we perceive certain limiting factors in that bank's creditworthiness compared with domestic and international peers rated one notch higher. There also may be limited justification to raise the ratings on the banks that are already our highest rated, absent compelling improvements in their credit profiles.

We will continue to consider developments in the performance and characteristics of each bank we rate, ratings relativities, and changes in economic and industry risks. While in general we expect asset quality problems to abate and earnings to rise, we will monitor the higher-risk exposures of certain banks and any unexpected reemergence of pressures. Depending on such factors, we could take some additional rating actions prior to or at the time of a potential anchor move.

Besides the outlook revisions to positive, have you taken any other rating actions related to the BICRA?

Yes. We revised the outlooks on several banks to stable from negative, largely because we have become less pessimistic about their asset quality. While some of these banks have had material exposure to areas most affected by the pandemic (for example, energy and commercial real estate), the improvement in the economy, as reflected in the now stable economic risk trend, has reduced stress on loan portfolios. Our ratings on three Puerto Rico-based banks were unaffected by our changed view on the industry risk trend. However, we recently took positive rating actions on those banks related to performance improvements (see "Rating Actions Taken On Three Puerto Rican Banks On Better-Than-Expected Financial Performance," April 21, 2021).

How would a change in the U.S. bank anchor affect your ratings on nonbank financial institutions?

A change in the anchor likely would not affect our ratings on NBFIs.

We also use anchors for our ratings on finance companies (fincos) and securities firm, which we typically set three and two notches, respectively, below the bank anchor in each country to reflect certain higher risk factors in each sector. If we revise up the bank anchor, we may widen that typical notching, since factors such as the improved bank regulatory track record have little direct relevance to NBFI sectors.

On the other hand, better bank regulation can have some indirect benefits for NBFIs, such as better access to funding from a healthy bank sector. U.S. banks generally had the capital and liquidity to continue to provide funding through the pandemic, which benefited NBFI sectors.

While we currently do not expect to revise the NBFI anchors, as we emerge from the economic wake of the pandemic and evaluate the BICRA, we will consider questions such as:

  • Have the finco and securities firms industries performed better and with less risk than we might have expected when we first set their current anchors several years ago, as demonstrated in part during the pandemic?;
  • Does tighter bank regulation materially benefit fincos and securities firms in any indirect ways, such as by giving them better access to bank funding or by giving them more business opportunities in areas where regulation limits banks?;
  • Has the surge in liquidity in the financial system, on the back of the Fed's quantitative easing, widely benefited the finco and securities firms industries, most notably through structurally better funding?; and
  • Has the regulatory oversight for NBFIs improved along with bank regulation over the past several years?

Lastly, while we may not revise the anchors for NBFIs, the issues addressed in these questions may affect our company-specific analysis and ratings to a degree they haven't already. For instance, improved funding or increased business opportunities could lead to higher ratings for certain NBFIs even absent a higher anchor.

Related Criteria

Related Research

This report does not constitute a rating action.

Primary Credit Analyst:Brendan Browne, CFA, New York + 1 (212) 438 7399;
Secondary Contacts:Devi Aurora, New York + 1 (212) 438 3055;
Ben T Bubeck, CFA, New York + 1 (212) 438 2176;
Stuart Plesser, New York + 1 (212) 438 6870;

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